This article was co-written by Bob Hinkle, CEO of Metrus Energy, and Peter Orszag, Bloomberg Opinion columnist and CEO of Financial Advisory at Lazard. It was first published on Bloomberg Opinion on 7/21/21.
Double-entry bookkeeping, invented in the 15th century by the mathematician Luca Bartolomeo de Pacioli, has been fundamental to economic growth ever since. Now, not just economic activity but the very future of the planet requires another revolution in bookkeeping.
The accounting standard needed today is one capable of measuring the amounts of greenhouse gases that are emitted and removed from the atmosphere, and the goal of reaching a “net zero” balance between the two. Although the Greenhouse Gas Protocol has provided an agreed-upon way to account for corporate carbon emissions, there is still no standard measure to assess where companies stand on the path to net zero.
As one example of the accounting issues involved, consider carbon offsets, which are verified credits equal to 1 ton of carbon dioxide, generated from projects such as protecting forests, planting trees or replacing charcoal stoves with solar ones. It’s been suggested that such offsets could account for a 10th of the effort needed to reach net-zero emissions. But many questions remain unanswered. For example, how quickly would a protected forest have deteriorated without the offset project? Would a set of newly planted trees have been planted anyway, and once planted would they stay in the ground permanently? Will a family provided with a solar stove use it as its only stove, or alongside the old charcoal one? And so on.
One way to simplify things would be to buy carbon-emission permits from governmental cap-and-trade systems, and then lock them away so that carbon polluters cannot use them to emit a ton of CO2. This would ensure that the permits amount to averted emissions. This is the approach adopted by Climate Vault, an effort associated with the University of Chicago. However, if this were the only kind of permissible carbon offset, many legitimate net reductions would be missed. A tree that might be planted solely to generate an offset, for instance, would go unplanted.
Recently, Science Based Targets, a worldwide initiative to help companies reduce emissions, launched a process to develop a common definition and global standard for what net zero means for businesses. “SBTi created a North Star for corporate climate target-setting, and we are looking for it to now play a similar role for net-zero targets,” explained Tim Juliani of the World Wildlife Fund, which is part of the initiative.
SBTi requires member businesses to reduce their direct and indirect emissions to levels that are in line with the goals of the Paris agreement — that is, to levels that could limit warming to less than 2 degrees Celsius, and ideally 1.5 degrees. For businesses that have more than 40% of total emissions coming from their value chains, SBTi also requires actions to address emissions from their upstream and downstream activities. To date, roughly 1,600 companies have committed to set emissions-reduction targets through SBTi, including 63 among the Fortune 500. (A much larger number of companies, including 60% of the Fortune 500, have set emissions targets, but these vary in terms of what emissions are being measured, tracked and reported as well as the stated timetable for success.)
The Securities and Exchange Commission may also play an important role in setting emissions-disclosure requirements for corporations. It has already invited comments on how disclosure of carbon emissions and risks should be required from public companies. There would be substantial benefits to having a clear emissions-disclosure standard worldwide, so that multinational public corporate efforts could be better integrated into the global effort to hit net zero.
(One danger is that disclosure requirements for public companies might shift investments to privately owned companies not subject to the same rules. To the extent that happens, the effect on greenhouse gases will be undermined.)
De Pacioli’s invention promoted business activity and reduced, but clearly did not eliminate, unnecessary errors and outright fraud. And that’s basically what should be expected of new accounting standards for determining what it means for a company to reach net zero: fundamental effectiveness with imperfect adherence. Although it’s not yet clear exactly what net zero means, the stage is set for another pivotal accounting breakthrough.